In the January/February issue of Money magazine are the picks of a group of Morningstar analysts for 2011. I won’t spoil it for subscribers to the magazine who haven’t read it yet, but perhaps more interesting is the review than the 2011 picks is the results of last year’s picks.
Note that this is list was not developed by some guy on the internet or the Yahoo Message Boards making stock picks. This list was composed by a group of professional analysts who have access to all kinds of information on the companies. They spend all day analyzing charts, talking to company officers, and scouring financial statements and reports. Here is the list of last year’s picks, along with the results in total yearly return for each pick:
- Realty Income +38.2%
- NSTAR +17.8%
- Thermo Fisher Scientific +9.7%
- Exxon Mobile +7.6%
- Sysco +7.1%
- Novartis +3.9%
- Paychex +2.7%
- Johnson and Johnson +0.2%
- Wellpoint -4.4%
- Exelon -15.1%
Group Average: 6.1%, S&P 500 11.8%
Note a few things. First of all there was one outstanding pick that went up almost 40%. There was also one lousy pick that lost 15%. The group as a whole returned only 6.1%, compared to a 11% + that an investor could have gotten simply by purchasing an S&P 500 Exchange Traded Fund (ETF) like the SPiDeRS on the American exchange. This means that the analysts did not do as well as the market in general. The S&P 500, made of large cap companies, also didn’t do as well as the Midcap and Smallcap index in 2010. If an investor had bought the large cap, midcap, and smallcap SPDRS he/she would have trounced the professional.
Also note that only two of the stocks on the list did better than the S&P 500 Index. If a reader had followed the picks but only chose one or two of the stocks, he/she had a 50% chance of doing even worse than the average of the analysts picks and an 80% chance of doing worse than the S&P 500.
I’m not saying that I would necessarily do any better. (I actually did better than the analysts’ picks and the S&P500 in my personal portfolios, but that was just by luck.) The point is that making predictions over short time periods like a year is really just rolling the dice. Johnson and Johnson looked good, but then the Government decided to take over and regulate the health care industry, causing uncertainty. This drove investors away from health care stocks. Oil recovered in 2010, but not enough to help Exxon regain its former glory.
The market is a fickle thing. Add in random events and politics, and there is about as much chance of picking the stellar performers for the next year as there is of predicting the weather three weeks from today. It would be fairly easy, however, to predict that it will be warming up over the next six months if it were the start of January (in the Northern hemisphere).
Just like the long-term weather trends, one can also predict fairly well which companies will see earnings continue to grow. Because companies tend to trade within a specific range of Price Earnings (PE) ratio, just as the weather warms between January and June, one can expect companies that have growing earnings to increase in price over long periods of time. (Note that the long period of time is needed because current and near-term earnings will already be priced into a stock since they are very predictable. It is the level of uncertainty in predicting long-term earnings that causes the price of the stock to grow. This is because investors are paying less than what the stock will be worth in the future if the predicted earnings are achieved due to the risk that the company may miss earnings. This is called the risk premium. The greater the risk, the greater the discount paid for the stock by the market since the greater the needed return must be to justify making the investment).
If you want to try to pick individual stocks rather than simply picking up a set of ETFs or mutual funds, put the odds in your side. Don’t try to predict which stocks will beat the market over the next day, week, month, or year. Predict which will outperform over the next ten years. The former is strategy is speculating and the game for those looking for entertainment. The latter is investing and meant for those who actually want to make money.
To ask a question, email vtsioriginal@yahoo.com or leave the question in a comment for this blog.
Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and general information on picking stocks, handling money, and growing wealthy. It is not a solicitation to buy or sell stocks or any security. In addition the writer of this blog is not an accountant and writings should not be taken as tax advice which should be left to a CPA. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing
